The Weekly Update

This week is all about inflation with the UK leading with CPI, PPI, and RPI on Tuesday plus the German ZEW report and Eurozone Industrial Production followed by US PPI and CPI and Europe wide CPI data Thursday and Friday. So focus in the West will be on comments from the Fed and European central bankers.

In Asia we have a mass of Japanese data including trade, machine orders, industrial production, M2 and the report on foreign bond flows by Japanese investors and in China money supply, trade and CPI/PPI. We also have the Reserve Bank of Australia’s financial stability review to digest.

In Latin America, Mexico’s reserves will be of interest to the currency players as well as industrial production and the central bank minutes, and in Brazil we have a Selic rate fixing with expectations of 11.25% from 12.25% and retail sales to contend with, broadly a quiet week for data globally.

After a 12 year ban on new projects, Qatar Petroleum is to start a new natural gas project in the so-called North Field, Southern section, which they expect to have capacity of 2 billion cubic feet per day, which is the equivalent of 400,000 barrels of oil a day; this should come on-stream in around five years’ time.

One of the companies that should benefit from this new production is Nakilat (Qatar Gas Transportation Company) which has the largest LNG fleet in the world, mostly owned outright, but sometimes in joint ventures, with 67 LNG tankers and 4 LPG vessels.

We have positions in two bonds issued by Nakilat both maturing in 2033 and both have a scheduled sinking structure, that is they gradually get redeemed by a scheduled amount each coupon payment date up to maturity. One of the bonds has already been sinking, since 2010, while the other is due to start in 2021. As these are both scheduled amortisations we need to look at the average life to assess value so slightly more involved, as the calculation to determine ‘fair value’ needs to build in the extra cash you receive in addition to the coupon flow prior to the maturity date. Broadly, you have an extra payment, from principal, to reinvest as well as your regular coupon and so more compounding to take into hand.

Basically, these two bonds are cheap as a number of investors and their systems do not cope very well with this structure. Both bonds are rated but one is 1st Lien and the other 2nd Lien, a difference in the rating of one credit notch Aa3 verses A1. But both according to our Relative Value Model (RVM) are around 5 credit notches cheap and offer a return and yield of close to 12.5%.

The US housing market is a $26tn asset class, larger than the US stock market. Whereas the stock market and certain property hotspots have rallied in recent years, US house prices on average have stalled for the past 3 years. Alongside the rise in overall household debts, it’s worth noting that mortgage delinquencies also spiked up dramatically at the end of 2016 after six years of steady decline (mortgage delinquencies and defaults continued to rise for a couple of years following the Global Financial Crisis). These were a leading indicator of the 2008 market crash and were trending upwards from early 2006. In the 4th quarter of 2016 US prime mortgage delinquencies jumped from 2.6% to 3.1% of loans.

Since the peak of 7.3% in early 2010 there have only been a couple of modest single-quarter spikes in delinquencies, none as large as the latest, and all reverting downwards again in the following quarter. Given that we are close to recent historical average levels (~2.5% in the decade preceding the crisis) this may just be a fluctuation and future readings will not drift that far from current levels. But given the high levels of total household debt and the expected rise in rates and potential living costs it is also possible that we will see more households struggling to make mortgage payments on-time (even if these don’t rise due to typically fixed rates).

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